What is the 'Network Effect'

The network effect is a phenomenon where increased numbers of people or participants improves the value of a good or service. The internet is a good example. Initially, there were few users of the internet, and it was of relatively little value to anyone outside of the military and a few research scientists. As more users gained access to the internet, adding more content, information, and services, however, there were more and more websites to visit and more people to communicate with. The internet became extremely valuable to its users.

BREAKING DOWN 'Network Effect'

The rise of social media can be directly correlated to the network effect. The more users present on Twitter, sharing comments, links, and media, the more useful the platform became to the public. Similar growth through the network effect was seen with Facebook, YouTube, and Instagram, where the escalation of users fostered more interest from even more users. Corporations have also sought to participate with these platforms, adding to the collective as they seek to engage in the expanding conversations among the many consumers who interact online.

What the Network Effect Means to Businesses

A variety of services-for-hire apps and websites also benefit from the network effect; as more professionals list online they are available as dog walkers, tutors, or even electricians, even more customers begin to rely on such directories. Ecommerce sites such as Etsy and eBay grew in popularity as more sellers joined those marketplaces and sold their products to the influx of consumers who began to embrace shopping online. Ridesharing services also evolved and grew through the support of more participants signing up and expanding their reach across cities and states. As more drivers became part of Uber and Lyft, those brands gained in market value with passengers seeking rides.

The chief hurdle for any good or service which uses the network effect is to get enough users initially so that the network effects take hold. The amount of users required for significant network effects is often referred to as critical mass. After the critical mass is attained, the good or service should be able to obtain many new users since its network offers utility.

If too many people use the good or service, negative network effects can occur, such as congestion. In the internet analogy, having too many users on the internet can hypothetically cause the speed to deteriorate, decreasing utility for users. Thus providers of goods and services which use a network effect must ensure that capacity can be increased sufficiently to accommodate all users.

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